10-Q/A 1 form10qa092602final.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended June 30, 2002 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to _______________ Commission file number 001-14600 D.G. JEWELRY INC. (Exact name of registrant as specified in its charter) Province of Ontario N/A ------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1001 Petrolia Road Toronto, Ontario Canada M3J 2X7 ----------------------- ---------------------- (Address of principal executive offices) (Zip Code) (Registrant's telephone number, including area code) (416) 665-8844 -------------- Check whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| The number of shares outstanding of the registrant's common stock, no par value, on June 30, 2002 was 7,446,947 shares. D.G. JEWELRY INC. June 30, 2002 QUARTERLY REPORT ON FORM 10-QA TABLE OF CONTENTS PART I - FINANCIAL INFORMATION Page Number Item 1. Financial Statements Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001.4 Consolidated Statements of Income for the three and six months ended June 30, 2002 and 2001.........................5 Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001.....................6 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2001, 2000 and 1999................7 Notes to Consolidated Financial Statements.........................8-11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...........................................12-17 Item 3. Quantitative and Qualitative Disclosures About Market Risk...........17 PART II - OTHER INFORMATION Item 1. Legal Proceedings.................................................18-19 Item 2. Changes in Securities and Use of Proceeds............................19 Item 3. Defaults Upon Senior Securities......................................19 Item 4. Submission of Matters to a Vote of Security Holders..................19 Item 5. Other Information....................................................19 Item 6. Exhibits and Reports on Form 8-K.....................................19 Signature............................................................20 2 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-QA contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements, which are other statements of historical facts. These statements are subject to uncertainties and risks including, but not limited to, product and service demand and acceptance, changes in technology, economic conditions, the impact of competition and pricing, government regulation, and other risks defined in this document and in registration statements and other reports filed by the company from time to time with the Securities and Exchange Commission. All such forward-looking statements are expressly qualified by these cautionary statements and any other cautionary statements that may accompany the forward-looking statements. In addition, D.G. Jewelry Inc. (the "Company") disclaims any obligations to update any forward-looking statements to reflect events or circumstances after the date hereof. 3 PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS D.G.Jewelry Inc. Interim Consolidated Balance Sheets As of June 30, 2002 and December 31, 2001 (Amounts expressed in US dollars) (Unaudited) June 30, December 31, 2002 2001 $ $ ASSETS CURRENT ASSETS Cash 565,091 105,908 Accounts receivable 16,739,471 28,383,667 Inventories 18,390,674 20,454,134 Prepaid expenses and sundry assets 105,148 562,170 ---------------------------------------------- 35,800,384 49,505,879 PROPERTY, PLANT AND EQUIPMENT 724,092 1,463,282 INVESTMENT IN 50% OWNED INVESTEE COMPANY - 308,580 INTANGIBLE ASSET - 501,982 GOODWILL - 1,050,000 ----------------------------------------------- 36,524,476 52,829,723 ----------------------------------------------- LIABILITIES CURRENT LIABILITIES Bank indebtedness (Note 3) 18,395,375 15,765,744 Accounts payable and accrued expenses 5,812,198 7,838,575 Income taxes payable (1,684,388) 3,815,832 Long-term debt - current portion 221,852 211,175 ------------------------------------------------- 22,745,037 27,631,326 LONG-TERM DEBT 2,088,964 1,976,948 ------------------------------------------------ 30,638,635 29,608,274 SHAREHOLDERS' EQUITY CAPITAL STOCK (Note 4) 13,333,325 13,333,325 Impairment in value of notes receivable (1,408,533) (1,408,533) ------------------------------------------------- 11,924,792 11,924,792 ACCUMULATED OTHER COMPREHENSIVE INCOME(LOSS) (Note 5) (31,321) (188,317) RETAINED EARNINGS (202,966) 11,484,974 ------------------------------------------------ 11,690,475 23,221,449 ------------------------------------------------ 36,524,476 52,829,723 ------------------------------------------------

D.G.Jewelry Inc. Interim Consolidated Statements of Income For the six months ended June 30, 2002 and 2001 (Amounts expressed in US dollars) (Unaudited) For the period ended June 30, Three months Six months $ $ $ $ 2002 2001 2002 2001 SALES 1,035,951 9,066,005 10,074,348 17,911,001 Cost of Sales 5,705,823 5,987,000 11,758,927 11,957,389 GROSS PROFIT (4,669,872) 3,079,005 (1,684,579) 5,953,612 ---------------- ------------------ ----------------- ----------------- (450.78)% 33.96% (16.72)% 33.24% EXPENSES Selling 524,167 492,176 1,137,892 1,100,873 General and administrative 277,823 273,120 711,241 719,556 ----------------- ------------------ ----------------- ---------------- 765,296 1,849,133 1,820,429 801,990 ----------------- ------------------ ----------------- ---------------- Operating income 770,287 2,313,709 2,708,437 4,133,183 ----------------- ----------------- ----------------- ---------------- Interest expense 229,788 275,742 498,889 714,859 Other expenses 1,107,440 244,588 585,175 393,724 Loss / (Gain) on investment in 50% owned investee company 3,545 (10,683) 1,287 (54,254) ----------------- ----------------- ------------------ ---------------- 1,340,773 509,647 1,085,351 1,054,329 ----------------- ----------------- ------------------ ---------------- Income before income taxes and unusual item (6,812,635) 1,804,062 (4,619,063) 3,078,854 Unusual Item (Note 6) 12,434,112 552,522 12,569,127 552,522 ----------------- ----------------- ------------------ ---------------- Income Before Income Taxes (19,246,747) 1,251,540 (17,188,190) 2,526,132 Provision for income taxes (4,767,799) 419,622 (5,500,220) 865,799 ----------------- ----------------- ------------------ ---------------- Net income (14,478,948) 831,918 (11,687,970) 828,615 Earnings per common share (Note 7) (1.94) 0.13 (1.57) 0.25 ------------------ ----------------- ------------------ ---------------- Earnings per common share assuming dilution (Note 7) (1.94) 0.12 (1.58) 0.24 ------------------ ---------------- ------------------ ---------------- Average weighted number of shares Basic 7,446,947 6,649,655 7,446,947 6,649,655 ----------------- ---------------- ------------------ ---------------- Diluted 7,446,947 6,649,655 7,394,125 6,182,905 ----------------- ---------------- ------------------ ----------------

5 D.G.Jewelry Inc. Interim Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and June 30, 2001 (Amounts expressed in US dollars) (Unaudited) June 30, June 30, 2002 2001 $ $ Cash flow from operating activities: (11,687,970) 1,660,533 --------------- ----------------- Net income Adjustments to reconcile net income to net cash used in operating activities: Amortization 371,675 244,219 Decrease in accounts receivable 11,644,196 (3,777,773) Decrease in inventory 2,063,460 2,097,662 Decrease in prepaid expenses and sundry assets 457,022 351,864 Decrease in accounts payable and accrued expenses (2,023,377) (3,173,093) Increase in income taxes (5,500,200) 961,205 --------------- ----------------- Total adjustments 7,012,756 (3,295,915) --------------- ----------------- Net cash used in operating activities (4,675,214) (1,635,382) --------------- ----------------- Cash flows from investing activities: Purchases of property, plant and equipment - (111,102) Write-off of capital assets, goodwill, intangibles 1,916,497 - Investment in 50% owned investee company 308,580 (54,254) ---------------- ---------------- Net cash used in investing activities 2,225,077 (165,356) ---------------- ---------------- Cash flows from financing activities: Proceeds from bank indebtedness 2,629,631 1,854,879 Proceeds from loans payable 122,693 (124,127) Issuance of capital stock - 4,750 ---------------- --------------- Net cash provided by financing activities 2,752,324 1,735,502 ---------------- ---------------- Effect of foreign currency exchange rate changes 156,996 182,123 ---------------- ---------------- Net increase (decrease) in cash and cash equivalents 459,183 116,887 Cash and cash equivalents Beginning of period 105,908 274,133 ----------------- ---------------- End of period 568,091 391,020 ----------------- ---------------- Interest paid 471,552 714,859 ----------------- ---------------- Income taxes paid - - ----------------- ----------------

6 D.G.Jewelry Inc. Interim Consolidated Statements of Stockholders' Equity For the Years Ended December 31, 2001 and 2000 (Amounts expressed in US dollars) (Unaudited) Common Issued and Stock Outstanding Cumulative Number of Common Retained Translation Shares Warrants Amount Earnings Adjustments $ $ $ Balance as of December 31, 1999 6,407,780 1,265,000 11,917,040 8,532,180 613,896 Common Stock Issued 241,875 559,922 Foreign Currency Translation - (928,387) Net income for the year 1,381,907 ----------- ------------- ---------- ----------- ------------ Balance as at December 31, 2000 6,649,655 1,265,000 12,476,962 9,914,087 (314,491) Common stock issued 480,359 856,363 Foreign Currency Translation 126,174 Net income for the year 1,570,887 ----------- ------------- ----------- ----------- ------------ Balance as at December 31, 2001 7,130,014 1,265,000 13,333,325 11,484,974 (188,317) ========== ============ =========== =========== ============

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES a) Basis of Consolidated Financial Statements Presentation These Interim Consolidated Financial Statements have been prepared in accordance with Form 10-QA specifications and, therefore, do not include all information and footnotes normally shown in full annual Financial Statements. These financial statements consolidate, using the purchase method, the accounts of the company and its two wholly-owned subsidiaries, Diamonair, Inc. and Aviv, Inc. All material intercompany accounts have been eliminated. The investment in Netjewels.com is accounted for based on the equity method as at December 31, 2001 and has been written-off in its entirety as at June 30, 2002, as the Company has ceased activities in September, 2002. The financial statements have been prepared on a going concern basis which contemplates the realization of assets and the payment of liabilities in the ordinary course of business. The Company's future depends on its ability to maintain its bank lines of credit and vendor support. The Company has recently lost approximately 50% of its business due to a dispute with ShopNBC and, on September 23,2002, the Company was notified by its bankers that it was in default of certain of its covenants and that the bank is in the process of reviewing its options given the new developments. These matters raise substantial doubt about the Company's ability to continue as a going concern. b) Principal Activities The company was incorporated in Ontario, Canada on October 18, 1979. The company is principally engaged in the production and selling of jewelry in Canada and the United States of America. c) Bank Indebtedness and Cash Equivalents Cash and bank indebtedness includes cash in bank, amounts due to banks, and any other highly liquid investments purchased with a maturity of three months or less. The carrying amount approximates fair value because of the short maturity of those instruments. d) Other Financial Instruments The carrying amount of the company's other financial instruments approximates fair value because of the short maturity of these instruments or the current nature of interest rates borne by these instruments. e) Long-term Financial Instruments The fair value of each of the company's long-term financial assets and debt instruments is based on the amount of future cash flows associated with each instrument discounted using an estimate of what the company's current borrowing rate for similar instruments of comparable maturity would be. f) Inventory Raw materials and work-in-process are valued at the lower of cost (first-in, first-out basis) or market. Finished goods are valued at the lower of cost or market. Cost is calculated using selling price less normal gross margin. g) Property, Plant and Equipment Property, plant and equipment are recorded at cost and are mainly depreciated on the declining balance basis over their estimated useful lives. Leasehold improvements are amortized on the straight-line basis over the terms of the lease. h) Goodwill Goodwill is the excess of cost over the value of tangible assets acquired on the acquisition of subsidiary companies. It is being amortized on the straight-line basis over 40 years. The valuation and amortization of goodwill is evaluated on an ongoing basis and, if considered permanently impaired, goodwill is written down. The determination as to whether there has been an impairment in value is made by comparing the carrying value of the goodwill to the projected undiscounted net revenue stream to be generated by the related activity. 8 i) Sales Sales represent the invoiced value of goods supplied to customers. Sales are recognized upon delivery of goods to customers, notwithstanding the liberal payment terms provided to the customers. In some cases, particularly on product sales to retailers owned by the members of the Berkovits family, the Company provides generous terms, which coincide with the retailers' cash availability . j) Foreign Currency Translation The translation of the Interim Financial Statements from Canadian dollars ("CDN$") into United States dollars is performed for the convenience of the reader. Balance Sheet accounts are translated using closing exchange rates in effect at the Balance Sheet date and income and expense accounts are translated using an average exchange rate prevailing during each reporting period. No representation is made that the Canadian dollar amounts could have been, or could be, converted into United States dollars at the rates on the respective dates and or at any other certain rates. Adjustments resulting from the translation are included in the cumulative translation adjustments in stockholders' equity. k) Use of Estimates The preparation of Interim Financial Statements requires management to make estimates and assumptions that affect certain reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the Interim Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. l) Long-Lived Assets On January 1, 1996, the company adopted the provisions of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." SFAS No. 121 requires that long-lived assets to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Management used its best estimate of the undiscounted cash flows to evaluate the carrying amount and have determined that no impairment has occurred. m) Stock Based Compensation In December 1995, FAS No. 123, "Accounting for Stock-based Compensation", was issued. It introduced the use of a fair value-based method of accounting for stock-based compensation. It encourages, but does not require, companies to recognize compensation to employees based on the new fair value accounting rules. The company chose to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the company's stock at the measurement date over the amount an employee must pay to acquire the stock. n) Credit Risk The company's financial assets that are exposed to credit risk consist primarily of accounts receivable. The company, in the normal course of business, is exposed to credit risk from its customers, substantially all of which are in the jewelry industry. (See page 13 of "Management's Discussion and Analysis of Financial Condition and Results of Operations") o) Net Income and Fully Diluted Net Income Per Weighted Average Common Stock Net income per common stock is computed by dividing net income for the period by the weighted average number of common stock outstanding during the period. Fully diluted net income per common stock is computed by dividing net income for the period by the weighted average number of common stock outstanding during the period, assuming that all stock options were exercised. Stock warrants have not been included in the fully diluted net income per common stock calculations as their inclusion would have been anti-dilutive. 9 2. GOLD CONSIGNMENT AGREEMENT During the year 2001, the company entered into a gold consignment agreement with a Gold Lender. Under the terms of the agreement, the company is entitled to lease a maximum dollar limit of gold totaling $4,680,000. The consigned gold is secured by certain property of the company including its inventory and equipment. Title to such gold remains with the gold lenders until the company purchases the gold. However, during the period of consignment, the entire risk of physical loss, damage or destruction of the gold is borne by the company. The purchase price per ounce is based on the daily London Afternoon Fixing Price. The company pays the gold consignors a consignment fee based on the dollar value of gold ounces outstanding as defined in the agreement. The consignment agreement contains restrictive covenants relating to maximum usage, net worth, working capital and other financial ratios, for which the company is in compliance, and may be terminated by the Company or the respective Gold Lender upon thirty (30) days notice. 3. BANK INDEBTEDNESS The bank indebtedness bears interest at the bank's prime lending rate plus 3/4% per annum. As security, the company has provided a general assignment of accounts receivable, a general security agreement constituting a first charge over all present and future personal property of the company and an assignment of key man life insurance of a director payable to the bank. The facility contains covenants specifying minimum and maximum financial ratios. The agreement contains restrictions on changes in ownership and line of business, on further encumbrances of assets and on the guarantees and other contingent liabilities. See Item 2 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" at pages 13 and 16. 4. CAPITAL STOCK a) Authorized An unlimited number of common stock 5,000,000 class 'A' preference stock Issued June 30, December 31, 2002 2001 $ $ 7,446,947 Common Stock (7,130,014 13,220,100 13,220,100 for December 31, 2001) 1,265,000 Warrants 113,225 113,225 ------------- -------------- $ 13,333,325 $ 13,333,325 b) Stock Option Plan 1996 Plan - 500,000 authorized (all issued) 1998 Plan - 500,000 authorized (all issued) 1999 Plan - 500,000 authorized (10,500 issued) 2001 Plan - 500,000 authorized (no shares issued)

10 5. COMPREHENSIVE INCOME The company has adopted Statement of Financial Accounting Standards No. 130 "Reporting Comprehensive Income" as of January 1, 1998 which requires new standards for reporting and display of comprehensive income and its components in the financial statements. However, it does not affect net income or total stockholders' equity. The components of comprehensive income are as follows: June 30, December 31, 2002 2001 $ $ Net Earnings (11,687,970) 1,570,887 Other comprehensive income (loss): Foreign currency translation adjustments 156,996 126,174 -------------- -------------- 1,697,061 ============== Accumulated other comprehensive loss, December 31, 1999 613,896 Foreign currency translation adjustments for the year ended December 31, 2000 (928,387) -------------- Accumulated other comprehensive loss, December 31, 2000 (314,491) Foreign currency translation adjustments for the year ended December 31, 2001 126,174 -------------- Accumulated other comprehensive loss, December 31, 2001 (188,317) Foreign currency translation adjustments for the three months ended March 31, 2002 (44,416) -------------- Accumulated other comprehensive income, June 30, 2002 (11,530,974) (232,733) ============= ==============

6. UNUSUAL ITEM The 2002 amount represents write-offs associated with: accounts receivable from affiliated retail stores, investment in NetJewels.com, capital assets, goodwill, intangible asset, adjustment to the provision for the litigation associated with Haymarket LLC and the legal expenses associated with this litigation. It is management's opinion that the amount provided for the litigation will be sufficient to cover the ultimate liability. Additional write-offs may be required in the future. 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Company's consolidated financial statements and related notes included elsewhere in this Form 10-QA. The Company's future success as a manufacturer and distributor of value-priced, stone-set jewelry will be influenced by several factors, foremost of which is the Company's ability to maintain its bank lines of credit and vendor support. Other factors include: technological developments in the mass production of jewelry, the Company's ability to efficiently meet the design and production requirements of its customers, and the market acceptance of its jewelry. Further factors impacting the Company's operations are the Company's ability to control costs, management's ability to evaluate the public's tastes and orders to target satisfactory profit margins, the ability to develop and manage the introduction of new designed products, and competition. Quality control is also essential to the Company's success, since customers demand compliance with design and product specifications and consistency of production. The Company's utilization of our high-volume manufacturing techniques sometimes results in excess inventories. In the past, the Company either sold these excess inventories in lots at prices which usually resulted in losses of the Company's investment in labor and overhead and without recovering the Company's full cost of stones, or the Company internally recycled the metal and most stones by disassembling the product, re-melting the gold or silver and removing the stones. This recycling resulted in additional incurred labor and overhead costs. Once Diamante established its factory outlet stores, it provided the Company with an opportunity to sell its excess inventories on more favorable terms. By selling to Diamante, the Company avoids the costs and losses that it had incurred in the past and the Company is afforded a more advantageous method of dealing with its excess inventories. In order to get full selling price for the products sold to Diamante and the other non-arms length retail distributors, the company has provided very generous payment terms, working closely with those retailers' available cash flow. The Company is the primary supplier of products to Diamante and the Company's accounts receivable from Diamante are fully secured by all the assets of Diamante, which security interest has been pledged by the Company to The Bank of Nova Scotia for the Company's financing facilities. In addition, the Company performs certain administrative functions for Diamante. Further, the Company is the primary supplier of products to Pegasus Acquisition Corp. I, which owns and operates four stores in the Phoenix, Arizona area. The Company is also the primary supplier of products to Florida Acquisition I. Corp. which owns and operates a store in Coral Gables, Florida. In addition, the Company also performs certain administrative and management functions for both Pegasus and Florida. The Company's accounts receivable from Pegasus and Florida are fully secured to the Company by the assets of Pegasus and Florida, which security interests have also been pledged by the Company to the Bank of Nova Scotia for the Company's financing facilities. The Company is also the primary supplier of products to Michigan Acquisition Corp. I, which owns and operates a new store in Birch Run, Michigan. The Company is also the primary supplier of products to Lilly's Jewelers 2001, Inc., which owns and operates six stores in West Virginia. In addition, the Company performs certain administrative and management functions for both Michigan and Lilly's. The Company's accounts receivable from both Michigan and Lilly's are fully secured to the Company by the assets of Michigan and Lilly's respectively, and these security interests have also been pledged by the Company to the Bank of Nova Scotia for the Company's financing facilities. 12 All of these retail stores are owned by family members of Mr. Berkovits, the Company's President. The company's financial assets that are exposed to credit risk consist primarily of accounts receivable. The company recognizes revenue and the resultant accounts receivable generally upon shipping of product. The company provides lengthy credit terms to its customers, particularly the companies owned by members of the Berkovits family. Related accounts receivable as at June 30, 2002, totaled approximately $8 million after write-offs. In addition, the Company participates in on-going programs and event opportunities wherein the Company uses its best effort estimates of sell-through of inventory provided by the Company for such opportunities. The accuracy of such estimates can only be determined upon the termination of such programs and/or events and the subsequent return of all unsold product from the customer. Generally, the Company does not provide products pursuant to long-term contracts. The Company has a jewelry supply contract with Zellers, Inc. of Canada that provides for the Company to be the exclusive supplier to Zellers of rings, which contract is to terminate in December 2004. The Company also entered into a contract with a key television retailer. The term of that contract is one of several issues in dispute with that retailer. The Company has notified that retailer that it has breached materially its obligations to the Company. The two parties failed to mediate their issues and are currently embroiled in litigation. As a result, the Company's revenues, accounts receivable and inventories have been materially adversely affected. As a result, the Company's relationship with its bankers has been adversely affected as has the valuation of accounts receivable and inventories. In addition, the Company's revenues have been significantly affected. The Company is in discussion with its bankers about what steps the Company and/or its bankers might be required to take given the above noted write-offs of assets and such discussions may result in jeopardizing the Company's ability to continue as a going concern (see Note 1(a) - Summary of Significant Accounting Policies). On November 21, 1997, the Company acquired substantially all of the assets of the wholesale jewelry division of Litton Systems, Inc., which division had operated under the trade name Diamonair, for approximately $5.8 million. The acquisition was accounted for using the purchase accounting method. In accordance with the purchase accounting method, Diamonair's results have been included in the Company's consolidated financial statements since the acquisition date. On February 10, 1998, the Company completed its acquisition of substantially all of the assets of Aviv, Inc., by assuming approximately $4.3 million in debt. The effective date of the acquisition was June 1, 1997. The acquisition was accounted for using the purchase accounting method. In accordance with the purchase accounting method, Aviv's results have been included in the Company's consolidated financial statements since the acquisition date. The Company continuously reviews its administrative costs to determine if there are areas where expenses could be reduced through further integration and consolidation of the acquisitions. Although the Company expects to achieve some level of consolidation, these potential cost reductions are limited in many areas because (i) operating in the United States and Canada limits the advantages of consolidating certain accounting and human resources functions and (ii) management believes that maintaining the existing Diamonair sales offices and manufacturing facilities will be beneficial for maintenance of this 13 division's existing customer relationships and will increase the Company's opportunities in the United States. Fluctuations in the Canadian dollar against other currencies, especially the U.S. dollar, may have a material effect on the Company's results of operations. A substantial portion of the Company's sales and purchases are set in U.S. dollars or are influenced by local currency against the U.S. dollar. To date, the Company has not sought to hedge the risks associated with fluctuations in exchange rates and currently does not have a policy relating to hedging. Results of Operations Three Months Ended June 30, 2002 Compared to Three Months Ended June 30, 2001 Revenues. Revenues for the three months ended June 30, 2002 were approximately $1 million, or approximately an 88.5% decrease over the three months ended June 30, 2001 revenues of approximately $9 million. Expected orders from ShopNBC have failed to materialize in the quantities expected and has resulted in litigation between the two parties (see comments above at page 13). Gross Profit. Gross profit for the three months ended June 30, 2002 decreased by approximately $7.7 million, or approximately 252% to a deficit of approximately $4.7 million, as compared to approximately $3.1 million for the three months ended June 30, 2001. Gross profit for the three months ended June 30, 2002 was a negative 450.78% as compared to a positive of 33.96% for the same period in the previous year. This decrease in the gross profit is primarily due to large write-downs of inventory necessitated by the rupture in the relationship with ShopNBC (See page 13). Selling Expenses. Selling expenses for the three months ended June 30, 2002 increased by approximately $32,000, or approximately 6.5%, to $524,167 as compared to $492,176 for the three months ended June 30, 2001. This increase is attributable to the increase in salary expense. Administrative Expenses. Administrative expenses for the three months ended June 30, 2002 increased by approximately $4,700, or approximately 1.7%, to $277,823, as compared to $273,120 for the three months ended June 30, 2001. Interest Expense. Interest expense for the three months ended June 30, 2002, as compared to the three months ended June 30, 2001, decreased by $45,954, or approximately 16.7%, to $229,788. This decrease was mainly the result of lower interest rates and smaller loan amounts during the period. Unusual Item. The Company has decided to recognise an impairment to its assets values and has written down: accounts receivable from the affiliated retail groups ($8.0 million), its investment in the 50% owned subsidiary, NetJewels.com ($0.1 million), capital assets ($0.7 million), goodwill ($1.0 million), intangible assets ($0.4 million), loans receivable from the retail group (1.6 million). Additional write-offs may be required in the future. 14 As a result of the above factors, the company experienced a net loss for the three months ended June 30, 2002 of $14,478,948 as compared to the three months ended June 30, 2001 when the company had net income of $831,918. Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001 Revenues. Revenues for the six months ended June 30, 2002 were approximately $10 million, or approximately a 43.8% decrease from the six months ended June 30, 2001 revenues of approximately $17.9 million. Expected orders from ShopNBC have failed to materialize in the quantities expected and has resulted in litigation between the two parties (see comments above at page 13). Gross Profit. Gross profit for the six months ended June 30, 2002 decreased by approximately $7.6 million, or approximately 128%, to a loss of approximately $1.7 million, as compared to approximately $12.0 million gross profit for the six months ended June 30, 2001. Gross profit for the six months ended June 30, 2002 was a negative 16.72% as compared to a positive of 33.24% for the same period in the previous year. This decrease in the gross profit is primarily due to large write-downs of inventory necessitated by the rupture in the relationship with ShopNBC (See page 13). Selling Expenses. Selling expenses for the six months ended June 30, 2002 increased by approximately $37,000, or approximately 3.4%, to $1,137,892 as compared to $1,100,873 for the six months ended June 30, 2001. This minor increase is attributable to the increase in salary expense. Administrative Expenses. Administrative expenses for the six months ended June 30, 2002 decreased by approximately $8,000, or approximately 1.3%, to $711,241, as compared to $719,556 for the six months ended June 30, 2001. The decrease was mainly a result of reduced administrative salaries. Interest Expense. Interest expense for the six months ended June 30, 2002, as compared to the six months ended June 30, 2001, decreased by $215,970, or approximately 30.2%, to $498,889. This decrease was mainly the result of lower interest rates and smaller loan amounts, mainly during the first quarter of 2002. Unusual Item. The Company has decided to recognize an impairment to its assets values and has written down: accounts receivable from the affiliated retail groups ($8.0 million), its investment in the 50% owned subsidiary, NetJewels.com ($0.1 million), capital assets ($0.7 million), goodwill ($1.0 million), intangible assets ($0.4 million), loans receivable from the retail group (1.6 million). Additional write-offs may be required in the future. 15 The Company recorded $673,074 in unusual items related to the adjustment to the provision for the litigation associated with Haymarket LLC, and legal fees pertaining to this litigation. It is management's opinion that the amount provided for will be sufficient to cover the ultimate liability. The Company has reflected in the quarterly statements at June 30, 2002 its issue to Haymarket of the 316,933 shares at February 6, 2002 pursuant to the Court's order. It has reduced its potential liability to Haymarket LLC by the value of these shares issued as at February 6, 2002. Should final resolution of this litigation result in a credit to the Company for these shares at a value other than that at February 6,2002, the Company will make adjustments at that time. As a result of the above factors, the company experienced a net loss for the six months ended June 30, 2002 of $11,687,970 as compared to net income of $828,615 for the six months ended June 30, 2001. Liquidity and Capital Resources The Company currently has an operating line of credit with The Bank of Nova Scotia in the amount of approximately $18 million subject to certain margin requirements. As at June 30, 2002, the Company's bank indebtedness, net of cash, amounted to $17,830,284. The amount available to the Company is equal to 75% of "eligible accounts receivable", as defined in the Line of Credit Agreement, plus 50% of the inventory values up to a maximum advance against inventory of approximately $8.9 million. The Company utilized the credit line to borrow the $5.8 million and $4.3 million necessary for the acquisitions of Diamonair and Aviv, respectively. The Company's borrowings under the line of credit bear interest at Canadian prime plus 3/4% which at June 30, 2002 amounted to 5.25% interest on any borrowings payable monthly. The Company's obligations under the revolving credit are secured by a security interest on all of our assets, guaranteed by Diamante, Pegasus, Florida and by Lilly's, jewelry retail chains owned by Mr. Berkovits' daughter, and by Michigan, a jewelry retail operation owned by Mr. Berkovits' son-in-law, and are further secured by a mortgage on the property owned by a limited partnership controlled by Jack Berkovits and leased to the Company, which mortgage the Company has guaranteed. The Company had an outstanding gold lease under the gold consignment agreement of approximately $2.5 million which is part of the operating line of credit. Under the terms of the agreement the company is entitled to lease a maximum of $4.7 million of gold. The company's lenders perform an annual review of their facility provided to the company. This review is usually finalized by mid-summer and the company is at that time provided a renewal commitment with whatever covenants and conditions are mutually agreed upon. As at September 25, 2002, the company has not yet received a renewal for the 2002-2003 period. On September 23, 2002 the Company was notified by its bankers that it was in default of some of its covenants and, given the ShopNBC situation, it was considering its options. Should the company's bankers fail to provide a renewal or were they to provide a renewal with conditions more stringent than the current facility, the company would find it difficult, if not impossible, to operate successfully. In anticipation of such a development, the company is continually exploring alternate lending and financing facilities but cannot be assured of success in that regard in the short term, should it become necessary to replace the company's bankers (See: Note 1(a) - Summary of Accounting Policies) At June 30, 2002, the Company had loans outstanding from its principal shareholder, Jack Berkovits, of approximately $1.86 million, which bear interest at 12 % per annum. 16 In May 1999, the Company issued 615,385 shares of common stock and an aggregate of 172,308 warrants exercisable at $8.13 per share in connection with a private placement offering. The exercise price of the warrants is subject to adjustment in certain circumstances. These warrants are exercisable from May 1999 until May 2004. The Company issued 615,385 shares of common stock to Haymarket, LLC, 110,769 warrants to purchase common stock to Haymarket, LLC, and 61,539 warrants to purchase common stock to Oscar Gruss & Son. Pursuant to the Common Stock Purchase Agreement between Haymarket, LLC and the Company, the number of shares purchased by Haymarket, LLC was to be adjusted to reflect a reset in the purchase price of the shares acquired according to a detailed formula set out in the Agreement. On February 6, 2002, in light of the appeal decision of the Appellate Division, First Department, of the New York Supreme Court issued on January 17, 2002, the Company issued 316,933 shares to Haymarket, LLC. See "Part II - Item 1 - Legal Proceedings." During 2001 the company entered into an arrangement whereby approximately $800,000 (settlement value) of trade payables were settled by way of issuing Common Stock to the suppliers. The issued shares are held in escrow until October, 2002 at which time if the stock price is trading below the agreed upon settlement value before October, 2002 the company will be held liable for the difference. The net cash used in operating activities decreased by approximately $4.7 million for the six months ended June 30, 2002 over June 30, 2001. This was due mainly to a decrease in accounts receivable mostly due to the write-off of some accounts receivable from the affiliated retail group of $9.4 million and a decrease in income taxes payable of $ 5.5 million. Accounts payable increased by approximately $1.2 million. The Company decided to write-off capital assets, goodwill and intangibles of $1.9 million. The cash flow from bank financing decreased by approximately $775,000 as at June 30, 2002 as compared to the previous period in 2001. The Company repaid approximately $247,000 less in loans as compared to the previous period. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not Applicable 17 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In December 1999, Haymarket LLC ("Haymarket") commenced an action against the Company in the Supreme Court of the State of New York, County of New York, alleging that D.G. had breached the terms of a Common Stock Purchase Agreement (the "Agreement') entered into by the parties, and seeking undetermined damages. In its defense, the Company asserted that Haymarket was barred from enforcing the agreement because it had wrongfully and in bad faith depressed the price of the Company's stock. The issue of liability was tried before a jury in November 2000. On November 16, 2000, the jury returned a verdict in the Company's favor. The judge thereafter set aside the jury verdict and directed a verdict for Haymarket, and on December 13, 2000, the court entered judgment for Haymarket, ordering the delivery of 316,933 shares of the Company's stock (the "Reset Shares") to Haymarket pursuant to a reset provision in the Agreement. On January 17, 2002, the Appellate Division, First Department of the New York Supreme Court affirmed the decision of the IAS Court setting aside the jury verdict in favor of the Company and entering judgment in favor of Haymarket on its claim against the Company for breach of the Agreement. The Company is seeking leave to appeal further to the New York Court of Appeals. On February 6, 2002 the Company delivered a share certificate for 316,933 shares to Haymarket in satisfaction of the judgment. The IAS Court will also assess damages owing to Haymarket for the delay in delivery of the reset shares, based upon the difference between the actual value of the reset shares when required to be delivered under the Agreement in October 1999, and the actual value of the reset shares on February 6, 2002, when they were delivered. The IAS court has specifically declined to enforce a liquidated damages provision in the Agreement under which damages would have been calculated at a rate of two per cent (2%) per day during the period the shares were not delivered. On May 4, 2001, Southridge Capital Management LLC, Cootes Drive LLC and York LLC commenced an action in the Supreme Court for the State of New York against D.G. Jewelry Inc., Samuel Jacob Berkovits and another. The Company and the other defendants removed the action to the United States District Court for the Southern District of New York on June 4, 2001. The complaint alleges tortious interference with contract, defamation and trade libel against the Company and Mr. Berkovits, and seeks compensatory damages, punitive damages and costs. The Company has counterclaimed against plaintiff Southridge Capital Management LLC for defamation. Management believes that the complaint is without merit, and it intends to defend the case vigorously. On Thursday, August 15, 2002, Mark Valentine, former Chairman of Canadian broker-dealer, Thomson, Kernaghan, was arrested and charged by U.S. and Canadian federal agents for several felonies relating to a massive securities fraud and money-laundering scam that has resulted in indictments against 58 people. Mark Valentine was alleged by the Company in its litigation with Haymarket LLC to have carried out short selling and manipulation of the Company's stock on behalf of Haymarket. The Company is seeking a legal opinion as to whether these developments provide a basis for re-opening of its litigation with Haymarket in New York and/or for bringing forward claims against Valentine and others in Canada or elsewhere. The Company and one of its key clients, ShopNBC, have failed to mediate their contractual dispute. The Company intends to litigate to enforce its rights under a contract between the parties. Failure to resolve these differences have had a significant and adverse affect on the Company (see Note 1(a) - Summary of Significant Accounting Policies). 18 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS See disclosure under Item 6 regarding changes to outstanding warrants. ITEM 3. DEFAULTS IN SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 8-K filed February 4, 2002, reporting on appeal decision of Appellate Division, First Department, New York Supreme Court, issued on January 17, 2002 in the Haymarket litigation. 8-K filed April 8, 2002, reporting on the Resolution of the Board of Directors extending the period during which the 1,265,000 warrants issued in conjunction with the Company's IPO in April, 1997 may be exercised, for a further three years, until 4:00 pm Eastern Time on April 16, 2005, and also reducing the exercise price at which shares may be purchased on exercise of the warrants from $6.25 to $4.00. EXHIBIT 99 CERTIFICATION PURSUANT TO SARBANES-OXLEY 19 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. D.G. JEWELRY INC. Dated: September 26, 2002 By: /s/ Anca Periet --------------------- ANCA PERIET Principal Accounting Officer 20 EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of D.G. Jewerly Inc. (the "Company") on Form 10-Q/A for the period ended June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Samuel Jacob Berkovits, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (i) The Report fully complies with the requirements of section 13(a) or 15 (d) of the Securities Exchange Act of 1934, and (ii) The information contained in the Report fairly represents, in all material aspects, the financial condition and result of operations of the Company. /s/ Samuel Jacob Berkovits ---------------------------- Samuel Jacob Berkovits Chief Executive Officer ---------------------------- September 26, 2002 EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of D.G. Jewerly Inc.(the "Company") on Form 10-Q/A for the period ended June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Anca Perier, Vice President-Finance and Operations, and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (i) The Report fully complies with the requirements of section 13(a) or 15 (d) of the Securities Exchange Act of 1934, and (ii) The information contained in the Report fairly represents, in all material aspects, the financial condition and result of operations of the Company. /s/ Anca Perier ------------------------------------------ Anca Perier, Vice President-Finance and Operations, and Chief Financial Officer ------------------------------------------ Septermber 26, 2002

D G JEWELRY INC 10-Q/A